What more is there to say about 2020? It was a year that brought us the worst public health crisis in more than a century, hundreds of thousands of deaths on U.S. soil, and the agony imposed by lost family members, friends, incomes, and our very way of life. Amidst such a profound human toll, it’s difficult to complain much about the damage inflicted upon our economy, but COVID-19 and its economic impacts will be felt for years and — in some cases — for generations, as family businesses were lost, homes were repossessed, careers were derailed, and breadwinners succumbed to a terrible disease.
In 2020 we witnessed significant market volatility and rapid interest rate cuts reminiscent of the financial crisis. Unemployment levels spiked and supply chains were disrupted. Domestic demand fell precipitously in the wake of lockdowns, oil prices cratered, and equity markets plummeted, only to snap back and reach new all-time highs. Bank balance sheets swelled by 20% in a single year – growing by an astounding $2.7 trillion, while the U.S. dollar was devalued, crypto prices reached new highs, and the gamification of stock trading whipped retail investors into a frenzy.
Who would have ever predicted any one of these events, let alone that they would all occur in a span of 12 months?
How did we get here?
In an effort to stimulate the U.S. economy and counteract the effects of government-induced lockdowns, in March 2020, the Federal Reserve slashed rates twice in rapid succession, reducing the fed funds rate by a total of 150 basis points. In the most recent
Beyond the Fed’s actions, lower consumer spending and a dearth of good lending opportunities for banks have swelled bank balance sheets, putting further downward pressure on rates. This low rate environment has impacted everything from capital investments, interest rates on loans, mortgages, and savings accounts, and equity valuations. Even cash alternatives — such as
Where do we go from here?
An economic recovery will depend on a resolution of the COVID-19 crisis, enabling a restoration of our consumer-driven economy. Such a recovery has the potential to allow a surge in consumer spending as pent-up demand is unleashed, with the beneficiaries being restaurants, entertainment sources, travel-related businesses and locations, and durable goods. Much as the Roaring ‘20s followed the devastation of World War I and the 1918 influenza pandemic, it’s conceivable that a new period of social liberalization and economic excess could emerge by 2022, leading to inflation and a return to higher interest rates.
Those fortunate enough to have entered this crisis with excess cash on the sidelines may have already profited from the opportunity to follow Warren Buffett’s advice and “be greedy while others are fearful.” Others may have taken the opportunity to build up an emergency fund or a cash cushion to help withstand further shocks to the economy, which could still emerge.
For those holding cash, it’s important to make sure it is earning the most yield possible. Even in a low rate environment, it’s possible to eke out excess returns. For instance, while the average rate paid on savings accounts nationwide is a mere 0.05%, online banks are paying 0.40% to 0.60% on the very same FDIC-insured accounts. Some online solutions can help investors proactively manage their cash and secure rates as high as 0.80% on bank accounts that are FDIC-insured and same-day liquid.
While earning an extra 75 basis points might not seem like a lot, incremental return without incremental risk is the holy grail in finance. In the same way that investors would happily pick an S&P 500 Index fund that had lower fees, they should similarly seek options for their cash that pay higher returns. This may be the simplest and easiest way to pick up “alpha” in this market, with the simplest and most common asset class of all: cash.
As consumer spending picks up, we should see an increase in loan demand and banks’ wiliness to lend, which in turn should lead to an uptick in bank interest rates that may outpace a steepening yield curve. As a result, we expect the interest rates paid on online savings accounts should continue to outperform MMFs while the economy is rebounding.
Although this past year has been turbulent, to say the least, and interest rates appear range-bound, there is light at the end of the tunnel. Smart investors will position their portfolios to prepare for rising rates and ensure that their cash continues to track the highest interest rates in the market, while remaining ever vigilant for signs of inflation that could impact real returns.
If 2020 was a year most would prefer to forget, and 2022 may well be a year we will never forget, we can all hope that 2021 provides a safe and more sure-footed path to recovery.
